Wobbly Chinese banks hold key to truly free yuan

Beijing, Aug 5 | Updated: Aug 6 2005, 05:30am hrs
China feels confident enough about its rickety banks to have adopted a more flexible currency regime, but it may be a decade before the financial sector can withstand the shocks of a freely floating yuan and unbridled capital flows. For now, Beijing can rest easy that last months 2.1 percent revaluation and shift to a managed float may do more to spur the countrys backward banks on to greater reforms than to harm them. Jonathan Anderson, chief economist at UBS in Hong Kong, said it was always a great myth that a revaluation would damage the banks, because their exposure to foreign assets is small.

We agree that banks would have a harder time coping with a volatile floating exchange rate or a sharp capital account opening but neither of these is on the cards for the time being, Anderson wrote in a report.

Beijing is steadily purging its big four state-owned banks of bad loans, the legacy of years of politically directed lending, and plugging the resulting holes in their balance sheets with new capital.

Banks are also scrambling to improve the risk management tools needed to weed out good borrowers from bad including those firms ill-equipped to deal with currency volatility. But Wang Songqi, a financial expert from the China Academy of Social Sciences, said it would be at least a decade before China could abandon the capital controls that shield the yuan from the sort of speculative attacks that could sorely test its banks.

We wouldnt be able to handle the associated risks. Chinas non-performing loans are huge, we dont have developed financial markets and our regulatory ability is very, very poor, he said.


Some say Beijings biggest concern is not what damage foreign speculators could do to Chinas banks, but what would happen if domestic residents started to lose faith in the banks. This is ironic at the moment because policy makers are preoccupied in case businesses and households, which had $165 billion on deposit at the end of June, convert their foreign exchange into yuan and increase upward pressure on the currency.

But the fear is that one day the currency pressure will be in the other direction and that, if depositors by then can flock to better-run markets overseas, a run could pull the rug from under Chinas big-four state-owned banks.

That would be a nightmare for a government that might need to tap the savings mobilised by the banks to pay for pensions, healthcare and other unfunded liabilities, perhaps including further recapitalisation of the banks themselves.

Li Daokui, a professor at Tsinghua University in Beijing, calculates Chinas public liabilities at 60 percent of national income.

These large liabilities need to be financed. Its rational for the government not to allow household savings to flow out freely, Li said. Even if capital controls remain in place to prevent that from happening, some officials fear Chinas banks will bleed deposits once foreign rivals are allowed to begin conducting retail business in yuan. That will happen in late 2006 under promises made when Beijing joined the World Trade Organisation in 2001.


Onerous capital requirements for setting up branches make that unlikely, banking analysts say.

Still, the looming deadline, and the goal of selling shares overseas in the next couple of years, is injecting urgency into the drive by regulators to get local banks to shape up quick. Since late 2003 Beijing has pumped $60 billion of its foreign exchange reserves into three of the big four state commercial banks so they can write off bad loans.

The central bank has also issued $173 billion in loans to bail out financial institutions and reform state-owned banks, according to statistics compiled by Caijing magazine. But Western bankers and ratings agency officials familiar with the banks say they still have a mountain to climb before their basic banking skills approach western standards. China Construction Bank Chairman Guo Shuqing said in an interview with Reuters in May that 80 to 90 percent of his staff dealing with customers were simply not up to the job. Given such basic shortcomings, to say nothing of $200 billion or more in still unresolved bad loans, experts expect China to continue to make haste slowly in exposing its banking system to the rigours that full yuan convertibility would entail. Chinese banks need to be strong enough to withstand any macro volatility like a speculative attack on the currency, said May Yan, a bank analyst with ratings agency Moodys Investors Service in Hong Kong.